"Watch What They Do, Not What They Say"

Sydney M. Williams

Thought of the Day

“Watch What They Do, Not What They Said”

October 26, 2010

The Group of 20 finance ministers returned to their respective homes on Sunday from their meeting in Gyeonju, South Korea with, as the New York Times put it, a “veiled” decision to “refrain from competitive devaluation of currencies” – a pledge, not a written agreement A proposal by US Treasury Secretary, Timothy Geithner, to impose a specific 4% of GDP limit on trade surpluses (Germany’s is currently 6.1% and China’s is 4.7%), was rejected in favor of using “indicative guidelines”. To monitor and act as referee of global trade activity, the IMF was given increased funds and the composition of the board was altered to give more influence to emerging countries. According to the Wall Street Journal, the accord is one “that relies on goodwill and peer pressure to persuade countries to comply with internationally agreed norms, rather than enforceable sanctions.”

What makes the events in South Korea so timely is that the world is going through a wrenching change. The engines of growth over the past sixty years – the United States and Western Europe – are sputtering. It is the emerging nations – China, India, Brazil, Southeast Asia and even parts of Eastern Europe – that are leading the globe back to health. Gideon Rachman, in the “Life & Arts” section of this past weekend’s Financial Times, has a fascinating article, “End of the World as we knew it”. He writes that, following the financial crisis of 2008, a win-win attitude that embraced globalization “is now being replaced by a zero-sum logic, in which one country’s gain looks like another’s loss.” Some of that sense was evident in the news reports coming out of the meetings in South Korea. As the Wall Street Journal wrote in an editorial on Monday: “The real problem with the global economy is that most of the developed world, in particular the U.S., isn’t contributing as much as it should to the current world expansion.” America’s fixation with China serves as an example.

The concept of Mr. Rachman’s zero-sum logic was visible in the reported discussions emanating from Gyeonju. Concerns, especially those expressed by Mr. Geithner, going into the meeting include the accusation that China has not let the Yuan float freely. In turn, China and other surplus nations fear that another round of quantitative easing in the U.S. will lead to competitive devaluations of other currencies and, possibly, inflation. The University of Chicago’s John Cochrane, in this morning’s Wall Street Journal, asks: “Since when is every trade surplus or deficit an ‘external imbalance’ in need of correction?” Devaluing currencies to steal exports may serve a short term goal, but ignores the role of technology, productivity and wage flexibility in competing for trade. Devaluing currencies risk currency wars, protectionism and the ignition of global inflation. It is walking the walk, not talking the talk that investors should consider.

Twenty-five years ago five finance ministers (United States, West Germany, Japan, the U.K. and France) met at the Plaza Hotel where they agreed to devalue the dollar, in what became known as the Plaza Accord. The reasons had to do with America’s current account deficit, then at 3.5%, (especially that with Japan) and, according to Wikipedia, “to help the U.S. economy emerge from a serious recession that began in the early 1980s.” Of course, we now know that that recession had been over for three years – in November 1982. However, among the unintended consequences of that Accord was that an export-dependent Japan went into recession, leading to expansionary monetary policies, which four years later resulted in a real estate and stock market bubble. The Chinese – the intended victim this time around – one can be assured, are well aware of that agreement and its consequences.

The finance ministers did agree to revamp the IMF’s (which has 187 country members) 24-member board, making it more representative of today’s world, shifting six percent of voting power from the richest countries to developing ones. Europe will give up two of its nine seats and Brazil and India will no longer have to share a seat. Additionally, the G-20 agreed to double the quotas that determine how much each country contributes to, and may borrow from, the institution. As enforcer of the “indicative” Gyeonju agreement, the IMF may prove able, but there are many who question its effectiveness. The New York Times article quotes Eswar S. Prasad, a former IMF economist: “The IMF can say its piece, but it is ineffectual when it comes to influencing large economies.” They also quote Dominique Strauss-Kahn, the fund’s managing director: “We cannot oblige a country to do something, but what we can do is to notice that a country has a commitment and fulfills, or not, a commitment.”

Mr. Rachman may be correct in assigning the date on which the world changed to the fall of 2008, but I would suggest the spring of 2000 was a precursor. The equity bubble popped in March 2000 and, with the loss of $6 trillion in equity valuation, logically should have lead to a severe recession. The speculative bubble kept growing, fed by cheap money, only now in commodities, homes and bonds, thus postponing the day of reckoning. During those years, as consumer debt increased, the U.S. dollar lost 36% of its value (measured by the US Dollar Index). Despite the weak dollar, the current account deficit grew from 2% of GDP to 3.2% today, belying the argument that a cheap dollar is the way to increase exports. It was spending more than we earned that got us into our troubles today – a situation abetted by government. It is that fact, which is being addressed by consumers (and has been by businesses), that needs to be recognized and addressed by Washington.

Next month the G-20 leaders will meet in Seoul. This will be the fifth meeting since the aftermath of the credit crisis in the fall of 2008. Time will tell the success of the meeting. While it is no doubt positive that all parties continue to talk, I do worry that the sputtering engines of growth in the West may encourage our political leaders to tap into the latency of protectionism, a condition which lurks just beneath the surface. It is the “doing”, not the “saying” that needs to be watched.